Exchange Traded Funds, or ETFs, are a type of collective investment vehicle that owns a portfolio of securities and issues shares which are traded on a stock exchange or other organized market. Shares of an ETF are created by authorized participants (AP) by either delivering cash or a portfolio of securities or a combination of cash and securities to the ETF and receiving ETF shares in return. ETF shares may also be redeemed by APs by delivering ETF shares and receiving cash, portfolio securities or a combination thereof. Only an AP may create or redeem ETF shares. All other investors buy or sell ETF shares in an organized market.
All ETFs must be approved for issuance by the Securities and Exchange Commission (SEC). To date, all SEC-approved ETFs attempt to replicate the performance of a benchmark index. The SEC has not approved an ETF that is managed without reference to an index. An ETF that is managed without reference to an index is called an actively managed ETF.
In order to approve an ETF for issuance, the SEC has required that the market trading the ETF disseminate an indicative value of the ETF shares every 15 seconds during trading hours. Moreover, the SEC requires that any ETF that may be created by delivery of portfolio securities or redeemed in exchange for receipt of portfolio securities, publish the holdings of the fund every day. These two requirements have impeded the ability of ETF sponsors to create an actively managed ETF.
Some managed ETFs have been proposed based on securities other than equity securities. For example, a managed ETF has been proposed by Bear Stearns Asset Management, and is known as the Bear Stearns Current Yield Fund. The prospectus of the Current Yield Fund indicates that the fund assets will comprise mainly fixed income obligations, and explicitly states that it will not invest in “common stocks, preferred stocks, warrants, or other equity securities.” By restricting the portfolio securities to fixed income/debt securities, the importance of maintaining the confidentiality of the identity of the portfolio securities is decreased. That is, because these types of securities are quite fungible, and alternative equivalent securities are readily identifiable, there is little or no risk that the pricing of the portfolio securities will be affected by disclosure of their identity. In contrast, managed ETFs that focus primarily on equity securities remain impractical due to the risk that public disclosure of the specific equity securities in the fund portfolio may provide an indication of the ETF manager's investment strategy, thereby allowing the public to take on anticipatory positions in those specific securities.
In addition, a mechanism has been proposed to determine and publish pricing information of an actively managed ETF, and is described in U.S. Pat. No. 6,941,280 to Gastineau, the contents of which are hereby incorporated herein by reference. Nevertheless, these prior efforts remain deficient, and do not provide sufficient mechanisms to enable the existence of a managed equity-based ETF.